When buying a car, a washing machine or a piece of furniture, verifying the product’s quality is usually high on a shopper’s checklist. The same goes for stocks. Just as a big-ticket purchase is expected to function well for years, the companies in an equity portfolio should also stand the test of time.

But how can an investor know if the stocks held in a portfolio are truly durable? It’s not as simple as searching for consumer reviews about a TV. Instead, you need to find out how a fund manager evaluates the business attributes of the underlying companies and chooses the stocks for your portfolio. Dominant businesses, competitive advantages, innovation and management skill are just some of the features that define high-quality businesses that can deliver dependable cash flows over time.

Quality Features Underpin Long-Term Return Potential

Quality in stocks can be measured in different ways. Yet the characteristics of resilient companies have something in common—they tend to underpin consistent, long-term equity return potential. Over the last decade, the MSCI World Quality Index returned 12.4% annualized, outperforming the MSCI World Index (Display). And during past market crises, quality stocks usually fell less than the broader market, a pattern that we’ve observed over longer time periods and in both US and global stock markets.

Yet no equity portfolio is immune from weak spells, and even high-quality stocks may falter from time to time. In the first half of 2022, stocks tumbled as surging inflation, rising interest rates, Russia’s invasion of Ukraine and China’s COVID-19 lockdowns threatened to tip the world economy into recession. Quality stocks fell by 17.5%, underperforming the broader market.

But following past crises, quality stocks have rebounded over time. When it comes to equities, we believe the long-term benefits of quality stocks aren’t necessarily illustrated by short-term return patterns. In our view, the early 2022 performance of quality stocks was an aberration, driven by an extreme confluence of extraordinary events. When the dust settles, we believe the benefits of a quality-focused approach will reassert themselves. In this paper, we aim to show how investors can find companies that provide exposure to quality, which should ultimately reward them through a challenging period ahead.